Corporate Indemnification, Insurance, and Civil Law Mandates in Taiwan

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1 Corporate Indemnification, Insurance, and Civil Law Mandates in Taiwan Chen Hui-ling, Partner 1. Directors and Officers Liability Insurance and Corporate Indemnification Coverage 1.1 In recent years, directors and officers (D&O) liability insurance has been a focus of much attention in Taiwan's insurance market. As its name suggests, typical D&O insurance provides coverage against liabilities incurred by the directors, supervisors, and officers ("directors and officers") of the insured entity, and almost always includes corporate indemnification (also referred to as "corporate reimbursement") coverage as well. What is "corporate indemnification," and what does corporate indemnification coverage actually cover? 1.2 The corporate indemnification clauses of a D&O insurance policy typically provide that under certain conditions, the insurer will make a payment on behalf of (or reimburse) the insured entity in the event it is obligated as required, permitted, or not prevented by law to indemnify directors or officers of the company against claims incurred while acting in their official capacities. In short, corporate indemnification coverage insures the insured company itself against liability incurred by its directors and officers. 1.3 The term "corporate indemnification," conspicuously absent from Taiwan's laws, is a term imported from the Anglo-Saxon Common Law countries, where the concept has evolved over long years. Growing economic prosperity and active markets in modern times were accompanied by trends toward professional specialization and increasingly complex regulations. These developments sharply increased the operational risk borne by companies themselves and by their directors and officers. Over time, it came to be accepted that companies to give capable persons the confidence to serve as directors and officers and to fully contribute their expertise and ability must offer them protection and indemnity against liability incurred in the exercise of their official duties, including protection of their personal property and their reputations. This gave rise 1

2 to the corporate indemnification system, which has the goal of shifting to the company some of the risk of legal liability faced by directors and officers in the course of managing the company and performing their duties. Where an investor transfers its investment, the transferor in conjunction with the transferee(s) shall apply to the competent authorities for permission. 2. Overview of the US System as an Example 2.1 The corporate indemnification systems of the United States, and in particular of the state of Delaware, can illustrate the basic concepts underlying corporate indemnification. The corporate indemnification provisions of the law of Delaware allow for corporations to indemnify their directors and officers or other specified persons for reasonable costs and expenses incurred in lawsuits for acts done in their official capacities. Such costs and expenses may include court costs and attorneys' fees. These provisions are designed to encourage capable persons to accept positions as directors and officers of corporations, secure in the knowledge that the corporation will bear expenses incurred by them in exercising their duties and in defending their integrity and reputation (and that of the corporation) against unjustified lawsuits. The executive branch authority over overseas investment in Taiwan is the Ministry of Economic Affairs and its subordinate agency, the Investment Commission. 2.2 Under Delaware law, corporate indemnification provisions are categorized as either "mandatory" or "permissive." "Mandatory" indemnification provisions require a corporation to indemnify a director or officer who prevails in a lawsuit. "Permissive" indemnification provisions allow corporations to grant indemnification beyond the scope of the mandatory provisions. The exercise of this permissive authority for indemnification relies on a separate mechanism such as a resolution by the board of directors or a shareholders meeting on a case-by-case basis to decide whether the directors or officers acted in good faith or met other requirements. The laws of some US states also allow corporations to specify permissive indemnification directly in their articles of incorporation or through agreements with directors and officers. 2.3 Of course, corporate indemnification may not exceed the scope allowable by law. For example, indemnification of directors and officers may not violate public policy or ethics. And a prerequisite for indemnification is 2

3 that the director or officer in question has acted in good faith. One court has ruled that corporate indemnification could not overstep limitations under the Delaware indemnification statute. 2.4 Corporate indemnification is also subject to limitations under other US laws. For example, the Organized Crime Control Act authorizes the US Federal Deposit Insurance Corp. (FDIC) to prohibit insured depository institutions from making indemnification payments in connection with administrative or civil enforcement proceedings initiated by federal banking agencies, and from purchasing D&O liability insurance to cover such liabilities. 3. The Difference Between Corporate Indemnification and Insurance 3.1 In addition to the corporate indemnification system, another means of shifting legal liability from a company's directors, supervisors, and officers is to use insurance to transfer the risk to the insurer. D&O liability insurance, a product that has received considerable attention in the market recently, is such an insurance product. In fact, most D&O liability insurance policies cover not just the legal exposure of directors and officers, but also cover the company itself when it indemnifies its directors and officers under its corporate indemnification duties, shifting the indemnification risk from the company to the insurer. 3.2 So the corporate indemnification system and D&O liability insurance are in fact two vehicles for achieving the common objective of shifting legal liabilities that may be incurred by directors and officers. D&O liability insurance is a commercial product, offered for profit, under which the insurer, after assessing the risk and calculating the premium, agrees to bear a certain liability to settle claims. The corporate indemnification system, meanwhile, is designed so that companies, by law or agreement, can provide protections, under certain circumstances, for the property and reputations of their directors and officers so that they can confidently carry out their duties. The most significant difference between the two is that D&O liability insurance usually covers only uncertain or future risks, whereas the corporate indemnification system can extend to events that are already known or have already occurred. However, a company that already has an indemnification system in place may still be unable to reimburse losses of directors or officers in the event that the company becomes insolvent. In that event, if the company has an adequate D&O 3

4 liability insurance policy, the side of the policy that provides indemnification coverage to the company can be activated to settle the claims. 4. Applicable Law in Taiwan 4.1 The term "corporate indemnification" is nowhere to be found in the laws of Taiwan. This has led some to believe that Taiwan lacks a corporate indemnification system, and that company directors and officers have no recourse for recovering reasonable expenses incurred in lawsuits arising from their performance of their duties. In fact, Taiwan is not entirely lacking in laws that can be applied to address what kind of liability a company bears when its directors or officers face claims arising from acts done in their official capacities. Under Taiwan's Company Act (and except as otherwise provided thereby), the legal relationship that exists between a company and its directors, supervisors, and certain officers is a "mandate" relationship governed by Taiwan's Civil Code. The section of Taiwan's Civil Code dealing with mandate relationships expressly provides that if a mandatary (i.e. a director, supervisor, or officer), in the execution of the mandate, incurs necessary expenses, assumes necessary debts, or incurs injury through a cause for which the mandatary is not responsible, the mandatary is entitled to claim for reimbursement of the expenses or for damages from the principal (the mandator, i.e. the company). The principal thus bears the obligation to reimburse the expenses or debts and compensate the injury. That is to say, directors, supervisors, and officers are entitled under the civil code to claim for indemnification or compensation from the company for reasonable expenses, debts, or losses incurred in performing their duties. 4.2 Some controversy may arise, however, over whether a lawsuit filed against a director, supervisor, or officer in connection with the performance of their duties falls within the purview of "in the execution of the mandate" as contemplated by the Mandate section of Taiwan's Civil Code. And indeed the Mandate section of the Civil Code contains only general provisions designed to cover a range of similar mandate relationships, and so cannot be expected to regulate the corporate indemnification system as precisely as, for example, provisions of US laws drafted expressly for that purpose. When litigation arises over disputes related to corporate indemnification in Taiwan, this lack of specific legislation and issues of applicability of law will raise questions that will have to rely on court interpretations for 4

5 resolution. Unfortunately, in Taiwan there have not yet been any court judgments or precedents to shed light on how the courts will treat issues of corporate indemnification for expenses incurred by directors and officers, whether under the mandate provisions of the Civil Code or any other laws. 4.3 In fact, before the United States adopted specific legislation concerning corporate indemnification, its courts applied legal principles relating to mandate or trust relationships when interpreting issues related to corporate indemnification and its application. In the United States, corporate indemnification was eventually codified in bright line provisions, but Taiwan still lacks such specific rules. Opinions may diverge over whether the provisions of Taiwan's Civil Code dealing with mandate relationships are directly applicable to corporate indemnification. But there is little question that corporate indemnification coverage under D&O insurance policies would be upheld under Taiwan law, given that such policies typically provide that the insurer will compensate the insured entity in the event it is obligated as required, permitted, or not prevented by law to indemnify its directors, supervisors, or officers against claims incurred while acting in their official capacities. 5. Corporate Indemnification Agreement 5.1 If a company affirms that the corporate indemnification system can protect the interests of its directors, supervisors, and officers and give them the confidence to fully contribute their expertise and talents in the service of the company, then the company can take the initiative to adopt such a system in its articles of incorporation or to sign corporate indemnification agreements with the directors, supervisors, and officers. The company additionally can purchase D&O liability insurance to cover liability claims against directors, supervisors, and officers and simultaneously to cover the company's own liability for indemnification. Indeed, many companies now rely on such arrangements as a key inducement when vying for talent in a competitive market. 5